7 Nov 2016

How Bank Regulation Can Encourage a Cashless Economy

In India, most transactions are in cash, which is inefficient, insecure and an avenue for black money. Leaving your money in the bank earns you interest, while keeping cash doesn't. Trips to the ATM are a waste of time and money, and you may be pick-pocketed. Paying by card also gives you a record of your expenses, to understand how you're spending your money, and reduce it.

The Indian government is trying to promote a cashless economy, by opening bank accounts for crores of people. Unfortunately, many of these accounts have zero balance, because there's no incentive for the account holders to deposit money in them. The government then pressurised bank managers to ensure that the account holders have some balance in them, but bank managers ended up depositing a single rupee out of their own pocket in each bank account.

For cashless transactions to take off, it's not sufficient for people to have bank accounts. They should be incentivised to use them. How might we do that?

First, every bank account should allow unlimited cash deposits at any ATM. Not just the same bank's ATMs. Not just ATMs in the same city as your account. Deposits should be unlimited both in the rupee amount and in the number of transactions. This will encourage people to convert their cash to a bank balance, which will in turn encourage payments by card or online, rather than cash.

Second, and this is the opposite of the above, eliminate the rule requiring banks to provide three free ATM withdrawals of ₹10K each a month. Let banks charge for even one cash withdrawal. That will discourage cash transactions.

Third, any charges for ATM withdrawals should be a percentage of the amount withdrawn, rather than a fixed fee per transaction, like ₹50 per withdrawal. A fixed fee will encourage people to reduce the number of transactions, by withdrawing more money than immediately needed. Which means that they'll then prefer to pay by cash, since they'll have a lot of cash and perhaps insufficient bank balance. Fix that by making any charges a percentage of the amount withdrawn, not a fixed fee. If a bank wants to allow some free withdrawals, it should be a rupee limit ("Withdraw ₹10K free every month"), not a limit on the number of transactions ("Three free transactions a month").

Fourth, every bank account should offer unlimited free transactions by debit card, netbanking, IMPS, RTGS and ECS. That will encourage their use. Banks can charge for paper-based mechanisms like ATM withdrawal, cheque or DD. Or non-realtime systems like NEFT, which usually takes at least half a day for the money to be credited. Discourage all these by letting banks charge for them, while keeping realtime payment systems free and unlimited, to encourage their use.

Fifth, the aforementioned free transfers shouldn't trigger a minimum balance fee. If you pay by debit card, and that decreases your balance below the minimum limit, the bank shouldn't be allowed to charge you any penalty. The fees should apply only in case of an ATM withdrawal, cheque or NEFT transfer after which your balance is below the minimum. That will again encourage realtime transfers.

Sixth, banks shouldn't be allowed to collect interchange fees from shops and other establishments that let customers pay by card. These fees are effectively a subsidy from customers who pay by card to customers who pay by cash [1]. That does the opposite of encouraging card payments. Fix that by outlawing interchange fees. Interchange fees also incentivise retailers to not accept cards. Or refuse card payments for small transactions, like below ₹100 [2]. Or impose a surcharge, as petrol bunks do. Get rid of interchange fees, and all these perverse incentives go away [3].

The government should make these six changes in bank regulation, to encourage a cashless economy.

[1] The other problem with interchange fees are that they are a form of double-dipping. Banks are already being paid by customers, and they shouldn't be allowed to charge retailers again.

Besides, why should the bank charge the retailer rather than the other way round? Just as the bank is helping the retailer win business, the retailer is also helping the bank. If retailers didn't accept cards, cards would be useless, and banks would lose out on some business. So, both parties — banks and retailers — are helping each other. Neither side should charge the other a fee.

[2] The problem of retailers not accepting cards for small transactions can also be fixed by an interchange fee that's only a percentage of the amount paid, without a fixed component. That is, outlaw interchange fees of the form ₹15 or 1%, whichever is higher. Or ₹15 + 1%.

Even a percentage-based fee shouldn't be a higher percentage for smaller amounts, like 2% below ₹100, and 1% above. Because the higher rate will again discourage retailers from accepting card payments for small transactions.

It should be the same percentage for all amounts, so a retailer has nothing to lose by accepting two payments for ₹50 as opposed to one payment for ₹100.

[3] Without interchange fees, credit cards will have to charge customers more. For example, credit cards may no longer have an interest-free grace period — they might start charging interest from the instant you make a purchase. Or credit cards may have a (higher) annual fee. Or you may receive fewer benefits on your card. You'll pay more, in whichever way. Which will discourage people from getting credit cards and ending up indebted, or blowing up all their income due to temptation.

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